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Loss Reserve Reinsurance Casualty Actuaries in Reinsurance June 16, 2000. Loss Reserve Reinsurance - Current Accounting Treatment. GAAP - SFAS 113: Reinsurance consideration is not considered “premium” Gain or loss from retroactive reinsurance must be amortized
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Loss Reserve ReinsuranceCasualty Actuaries in ReinsuranceJune 16, 2000
Loss Reserve Reinsurance -Current Accounting Treatment • GAAP - SFAS 113: • Reinsurance consideration is not considered “premium” • Gain or loss from retroactive reinsurance must be amortized • Statutory Accounting - Chapter 22 of NAIC Manual: • Reinsurance consideration is not considered “premium” • Gain or loss from transaction flows through “other income” • No reduction in net loss reserves • Surplus gain is considered “Segregated Surplus” • Other special rules for retroactive reinsurance coverage • Outside the U.S.: • Rules vary, but most domiciles allow some immediate recognition of gain or loss from the transaction
Loss Reserve Reinsurance -Current State of the Market • Since 1996, the market for Loss Reserve Reinsurance has been very active. • Significant portion of traditional reinsurance market • Majority of finite reinsurance market • Gerling Global Financial Products: since 1997, 45% of bound transactions and 65% of revenue • Motivation for transactions has changed • Prior to SFAS 113, primary motivation was surplus relief • Since SFAS 113: • Statutory surplus relief still a motivation • Many other reasons for these deals
Loss Reserve Reinsurance - Deals that still work: • “Economic” reinsurance protection - pure risk deals • Reinsurance of a non-U.S. ceding company • U.S. cedants not subject to GAAP or SAP - public entities • U.S. insurance companies looking for statutory surplus protection • Mergers and acquisitions - “Purchase Accounting” exception • Loss reserve insurance deals - usually tax-motivated • “No accounting impact” as the primary benefit
Public/Government Entities • Includes State Funds as well as municipalities • These entities rarely use SAP or GAAP • Reasons for the increase in activity: • More Liabilities • More Assets • General trend toward privatization
Example - Statutory Surplus Protection • The Situation: Insurance Company A has $500 million of loss reserves on its balance sheet, including $50 million for Asbestos and Environmental claims (A&E). • The Concern: The company wants to: • 1. Unlock some of the “discount” in the loss reserves, and • 2. Protect Statutory Surplus against further reserve increases
Example - Statutory Surplus Protection Second layer 90% of $50 million Premium: $45 million First Layer Coverage $50 million Second Layer $20 million Carried Reserves Retention $450 million
Mergers and Acquisitions“Purchase Accounting Exception” • Under GAAP, Loss Reserve reinsurance can be accounted for as a guarantee from the seller if done in conjunction with an acquisition • Under SAP, “Segregated Surplus” can be turned into “Earned Surplus” after an acquisition • These deals are often structured like the Surplus Relief deals
Example - Environmental Remediation Insurance • The Situation: Company A, a gas utility, has $100 million of liabilities arising from pollution of old MGP sites. They have negotiated a claim settlement of $50 million with their casualty insurers, and payment is imminent. • The Concern: Company A wants the claims settlement excluded from taxable income, and wants to avoid including the claims settlement in the calculation of a rate reduction for its customers.
Example - Environmental Remediation Insurance • Benefits: • At inception, no net impact on the balance sheet or “true” income • Taxable income is matched with “true” income Coparticipation aligns interest of Company and Insurer Risk Layer 80% of $25 million Second Layer $20 million Premium: $50 million First Layer Coverage $50 million Current Estimate Retention $50 million Company Retention
Example: “No accounting benefit” is a benefit TREATY 1 Risky CAT/Stop Loss Reinsurance Client Company TREATY 2 Safer Loss Reserve Reinsurance • Treaty #1 is aggressively priced and highly risky • Loss Reserve Reinsurance provides income and stability for the Reinsurer and has minimal impact on current net premium and income • Transactions are unlinked and each passes the risk transfer test on a stand-alone basis
Theme of Presentation: • Accounting considerations drive much of the reinsurance business